»5 Minute Wrap Up by Equitymaster

On This Day - 21 DECEMBER 2015
Beware of Stories That Could Trim Your Portfolios Returns

In this issue:
» Small cap stocks biggest winners and losers in 2015
» Market roundup
» ...and more!
00.00
Richa Agarwal, Research analyst

Let me tell you a story.

The six words could be the most powerful to catch someone's attention. I bet they immediately made you sit straight, eager to read further.

Stories capture imagination, tap into emotions, and make it easy to form an opinion... A good story is irresistible.

Businesses thrive on stories. Some of the most successful brands were launched on the back of powerful stories. And stories have funded some of today's most disruptive startups. It's no wonder consultancies are making money from clients who want to benefit from effective storytelling.

The world of financial services is no exception to all this. Indeed, it is full of storytellers - the brokers, the markets, the economists, and even the managements. They all shape the opinions and decisions of investors.

Unfortunately, at times, their stories are far from reality. The one that seem to fool people are also the the loudest and most far-fetched.

There is no dearth of investors who have been trapped by strong story lines. Remember the dot com bubble? The narrative was strong enough to draw huge money to equity funds...to be followed by one of the worst financial crises.

Back home, a case in point is the popularity of IPOs of companies with bottomlines in the red and no convincing business model.

Last year, the story that swept the markets and helped the Sensex touch an all-time high was the acche din and recovery theme. A year later, with corporate performances undermining the theme, investors seem to be waking up to the realities.

Stories have a natural convincing power. So much so that at times they can disarm logic and yet make a lasting impression of the message they want to communicate.

As analysts who always meet managements before we recommend companies, we certainly come across a few that are good at unwinding a spool of well-connected words to weave a great investment case.

Yet, as we dig deeper and try to get to the how and when of it, it all looks tangled. This is truer in the cases of complex and B2B businesses where information sources are limited. And all you have to rely on is the management outlook.

While we have nothing against the art of effective communication, when it is all words with little data to support the story and little evidence when cross-checked with other industry sources, we do not mind giving it a miss.

Unlike the stories from our growing up years, believing in ones that have your hard-earned money at stake may not make for a fond memory. As such, beware of narratives. Focus on facts and reasoning. While not everything about a successful business is quantifiable, strong stories are no substitute for quality. Have a process and disciplined investing approach that leaves little scope for storytellers to incite an emotional response - be it fear or greed. Else for every false story you fall for, you will have a bitter story to tell.

Are your investing decisions often influenced by strong 'storylines'? Let us know your comments or share your views in the Equitymaster Club.


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3:00 Chart of the day

The calendar year 2015 has largely been a disappointing year for investors in the Indian stock markets. The benchmark BSE-Sensex is down about 6% this year. But this was not the trend across the board.

We came across some interesting statistics reported by The Hindu Business Line. As per the business daily, 10% of the stocks listed in the Bombay Stock Exchange delivered 100% or more returns between 31 December 2014 and 17 December 2015. 40% of the stocks delivered returns in excess of 20%. 50% of the stocks gained 10% or more.

It is noteworthy that about 95% of the stocks that delivered 100% or more returns belonged to the small cap space.

Today's chart of the day shows the top five gainers of the year - Mangalam Drugs & Organics Ltd, Uniply Industries Ltd, Cupid Ltd, Keerthi Industries Ltd and Himachal Fibres Ltd.

Which Stocks Delivered Highest Returns in 2015?

Had you invested Rs 1 lakh in each of these five small cap stocks, your total investment of Rs 5 lakh would have been worth a massive Rs 57 lakh! In other words, your investment would have multiplied 11 times in less than a year's time.

We talked earlier about the power of storytelling. Isn't the story that we just narrated a tempting one? Don't we all want to become rich, and fast?

Our experience in researching small cap stocks tells us that you could be in for big trouble if you just look at the rosy returns. When my team and I shortlist stocks for our Hidden Treasure small cap stock recommendation service, we do a thorough analysis of the company's business model, financial health, growth prospects, profitability management quality, and so on.

We just took a cursory glance at the financials of some of the small cap stocks that have delivered multi-fold returns in 2015. We noticed that some of these companies are loss-making...or have just turned profitable after some years of losses...or have very poor profitability.

While small cap stocks have been the biggest winners in 2015, they also lead the list of biggest losers. For instance, among the stocks that crashed 50% or more this year, nearly 97% belong to the small cap category.

So, the small cap space is a high-risk high-return zone and must be treaded cautiously.

We recommend you read this earlier 5Minute Wrapup edition titled The Art of Investing in Small Cap Stocks.

4:15

The Indian stock markets have been trading on a positive note. At the time of writing, the BSE-Sensex was trading higher by about 175 points (+0.69%). Barring consumer durables and healthcare indices, all sector indices are trading in the green with banking and metal indices leading the gains.

4:45 Today's Investing mantra

"Risk comes from not knowing what you're doing." - Warren Buffett

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